Corporate Mergers, Acquisitions and Restructurings

Mergers and Acquisitions -

Understanding Tax Free "Reorganizations"

Our tax system allows for certain transactions to be structured as "tax-free" mergers or acquisition, so long as they are properly classified under the relevant definitions a corporate "reorganization" of Internal Revenue Code section 368(a) (and the various other rules and regs associated therewith).  Under certain instances, a Company desires restructuring its business organization and may do so, tax-free, under Section 368(a)(1)(F) (colloquially, an "F Reorg").

Ensuring compliance with the relevant rules of these provisions is key in the instance a merger or acquisition as failing to meet any one of these requirements can easily "bust" the planned reorganization.

Rules for compliance can include:

·       Proper Amounts of Stock transferred

·       Right type of Stock Transferred

·       Right type and amount of assets transferred

·       Limitations on Cash or "Boot" utilized in the transaction

·       Proper Filings for State Merger Documents

·       Proper Continuation of Business Interest and Business Enterprise

The types of mergers are numerous, but they often involved a "triangular" merger, meaning that the entity diagram takes on a 'triangle shape' wherein a subsidiary of either the acquirer or the target is present.  These mergers, such as a Dropdown merger or a Forward Merger, often must follow certain rules concerning the stock that is being utilized for the consideration in the entity.

Upon completion of a merger, there are particular rules for the treatment of the target entity, the target shareholder and the Acquiror in terms of both nonrecognition of tax and the treatment of basis.

Mergers and Acquisitions -

Asset Purchase Provisions

There are also asset purchases.  An asset purchase is, generally, when an acquiring company decides to purchase all or substantially all of another company's assets.  The purchasing company may wish to do so for the purposes of receiving a step up in basis for the acquired assets.  Unlike a tax-free reorg, there is a taxable event that occurs in this transaction – namely that upon the sale the seller will recognize income to the extent that the Purchase Price exceeds the seller's adjusted basis.*

In certain cases, there may be a purchase of stock that is treated as an asset purchase under Section 338, if an election is made.  This allows the Purchaser of the Assets to  elect asset purchase treatment to receive a desired step up in basis to FMV for the assets of the Target Corp.  However, unless an election under 338(h)(10) is in effect, the Purchaser will be liable for the tax, under Section 1001, on the amount of the difference between each asset's adjusted basis and the FMV of the assets at the time of the sale.

 In the instance of an Asset purchase with a 338(h)(10), the Purchaser will not be liable to pay for the step up in basis, as is the case under the 338(a) treatment.  Instead, this gain under Section 1001, will be attributable to the Parent of the Target Corporation, who would have to pay this tax on the difference between the adjusted basis and the FMV.

Four Primary Benefits of a 338(h)(10) election:

·       Tax Free Sale of Stock for Seller

·       Basis Step in Assets for Purchaser

·       Structure Deal as an Asset Sale

·       Gain on sale of Assets attributable to Seller

Most Asset Purchase Agreements also include a "Purchase Price Allocation Sheet" attached as a specific exhibit.  This sheet generally reflects the assets that being sold, as categorized into seven Asset Class through an application of  Internal Revenue Section 1060 and Treasury Regulations 1.338-6, 1.338-7 and 1.1060-1(c).  These allocations will determine what amounts of the purchase price for all of the assets are to be allocated between the various classes.  The allocation generally works as a waterfall from the first class down to the seventh class, such that the Purchase Price is deemed as first applying to Class 1 assets (e.g. Cash), then to Class 2 assets (e.g. ), and so on until Class 7 Asset of Goodwill.  The logical reason is that Goodwill is to be allocated at the end of allocating monies to the more liquid and determinable assets.  Both Seller and Purchaser should broadly consider whether or not the purchase price should be agreed upon in a particular manner to properly reflect the transaction and negotiations they are undertaking.  If they do agree on an amount for any Class of Assets, that agreed upon amount will control for that class.  However, such an agreed upon amount must be included within a provision of the Asset Purchase Agreement. 

*recapture under Section 1245 can potentially occur.